16 February 2018

“Code breaking”: a revised professional statement for service charges in commercial property

On 1 April 2018, the Royal Institute of Chartered Surveyors (RICS) is set to launch a new professional statement on best practice in the management of service charges in commercial property. The statement will supersede the existing edition of the RICS Code of Practice: Service charges in commercial property (3rd Edition). The consultation on the draft has closed and whilst the industry awaits the formal response, the draft points to the direction that RICS proposes to take.

The key proposed change is that when managing service charge accounts, RICS members must act in accordance with 8 core principles (see box). The Code is no longer just advisory as to best practice, although it does contain wide ranging “best practice recommendations” to help professionals satisfy the mandatory requirements. Let’s assume that RICS launches the statement, broadly in the form proposed.  For those real estate practitioners negotiating new leases, what are the key points to consider?

  • Legal force: Even though the statement introduces mandatory principles, the statement cannot override the wording of the lease, whether an “existing” lease or a lease granted after 1 April. Therefore, the statement does not excuse a tenant from complying with its service charge obligations, as set out in the lease. However, the statement warns RICS members that there may be “legal and/ or disciplinary consequences” for departing from the statement. Therefore, the terms of the lease may say one thing, but the professional obligations on the individual/ firm may encourage and, in the extreme, require something different. However, whilst the contractual provisions of the lease take precedence, if that wording is not necessarily clear, the statement includes a best practice recommendation- “existing service charge clauses are to be interpreted as far as possible in line with the principles and practices” in the statement. The statement may embolden tenants to challenge existing landlord practice, particularly where the wording of the lease is not conclusive.  
  • New leases: Heads of terms (HOTs) occasionally refer to the Code, typically at the request of the tenant’s surveyor. However it is rare for landlords to accept service charge clauses that require compliance with, or even acknowledgement of, the RICS Code in the final form lease. There are exceptions, including the City of London Law Society service charge provisions, which are designed to comply, and the model commercial lease (the “MCL”), which makes express reference. In the MCL, the landlord must, in summary, “take into consideration” the provisions of the Code. There is no obligation to comply with the provisions, but given the rather vague nature of the drafting, and that of the Code, this is clearly open to differing interpretations. Inevitably, a landlord will prefer that rather than having an express requirement to comply, a tenant should rely on the professional obligations of those that it chooses to manage the service charge. We anticipate that with the proposed mandatory nature of some of the statement’s provisions, tenant surveyors will increasingly push for reference to the statement in HOTs, and in turn, tenant solicitors will insist on the same in the lease (imposing more stringent provisions that align directly with the statement’s requirements and expectations/ recommendations). Without doubt, the statement will add greater weight to their arguments.
  • Modernisation: The statement includes the following wording as a “best practice recommendation”: “As new leases are granted and older leases renewed, it is essential to bring service charge clauses up to modern standards”. This presents landlords with a conundrum. A landlord may update leases on grant/ renewal, but the service charge under existing leases will remain. The statement suggests that “interim arrangements” may be necessary until all leases have been modernised. Interestingly, the statement recommends that new leases are drafted with “sufficient flexibility to enable changes in best practice”. We anticipate further commentary in relation to this, on the basis that tenants in particular are looking for certainty in service charge drafting.  The statement goes further in relation to those “interim arrangements”: “Renewal leases might reflect the ideal service charge regime going forward, as well as the status quo, so that when the tipping point is reached, the owner can swap from the old lease service charge regime to the new”. A “dual” service charge…this won’t necessarily make service charge drafting simple…
  • Landlord and Tenant Act 1954: Broadly, if the tenant is being granted a renewal lease, it has the right to seek modernisation of the lease terms, if it can demonstrate “good reason” on the basis of “essential fairness”.  It’ll be interesting to see if tenants demand modernisation of service charge arrangements on the basis of the new statement, and then perhaps whether the debate progresses to court. 

The Core Principles

Professionals involved in the management of service charge accounts must act in accordance with the following principles:

  1. Owners and managers must seek to recover no more than 100% of the proper and actual costs of the provision or supply of the services unless the lease of the property gives them the explicit right to do so.
  2. Owners and managers must ensure that service charge budgets, including appropriate explanatory commentary, are issued annually to all tenants.
  3. Owners and managers must ensure that a signed statement showing a true and accurate record of the actual expenditure constituting the service charge is provided annually to all tenants.
  4. Owners and managers must ensure that a service charge apportionment schedule for their property is provided annually to all tenants.
  5. All expenditure that the owner and manager seek to recover must be in accordance with the terms of the lease.
  6. Service charge monies (including reserve and sinking funds) must be held in one or more discrete (or virtual) bank accounts.
  7. All interest earned on service charge accounts – or where separate accounts per property are not operated, a proper and reasonable amount of interest calculated on normal commercial rates – must be credited to the service charge account after appropriate deductions have been made. This applies, for instance, to bank charges, tax, etc.
  8. Where acting on behalf of a tenant, RICS members must advise their clients that if a dispute exists any service charge payment withheld by the tenant should reflect only the actual sums in dispute.

Edward is an associate in our Commercial Real Estate team.

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